Teaching Our Youth The Value Of Saving

Over the years, Jeff Cutter and I have covered many topics in this column that we feel are important to our youth, including the benefit of saving money, the value of creating a budget, managing risk, and the importance of creating a financial system. But last summer, we had to encourage our own children to start applying the lessons we had been teaching, as both of our oldest kids entered the workforce and got their first “real jobs.” That’s when my son, Max, and Jeff’s daughter, Maeve, each opened a Roth IRA. And we are proud to say that each of them have been consistently saving a portion of every paycheck they have earned throughout the year.
 
Jeff and I have made a commitment to try to educate as many young people as we can reach (not just our own kids) about the benefit of starting to save for retirement as early as possible. Last summer, we decided to publish an article about the benefits of opening a Roth IRA, since summer is the time when most kids start working or return to their summer jobs. We decided it would be a good idea to revisit that article, with the hope that many of you will hand it off to your high-schoolers, so they, too, can understand the benefits of opening a Roth IRA.
 
So, let’s get started.
 
A Roth IRA is an individual retirement account that offers tax-free growth on after-tax contributions. In other words, the owner of a Roth IRA does not get a tax deduction for his or her contributions, but all future withdrawals from a Roth, of both contributions and earnings, are tax-free, provided those distributions meet certain requirements. A Roth IRA is one of the most tax-advantaged retirement tools for a young person. Think about a farmer, who has just a handful of wheat seeds that weigh less than a pound. The farmer plants those seeds, lets them grow, and then harvests them at the end of the season. A few ounces of inexpensive seed turns into hundreds of pounds of valuable wheat.
 
Anyone can contribute to a Roth IRA as long as he or she has earned income from a job and has income below certain specified levels. However, contributions are limited to either $5,500/year if a person is under 50, ($6,500/year if a person is over 50) or the extent of earned income. So, if a summer job pays $3,000 and a kid does not “earn” any other money during the year, then the most he or she can contribute is $3,000 that year.
 
A Roth IRA is a great saving tool for young people, for many reasons. Young people are almost always eligible to make contributions (I have never met a teenager who exceeds the income limits); and for the same reason, those young people typically do not need the tax deduction that would otherwise be available for Traditional IRA contributions, as they are usually already in the lowest tax brackets. But most importantly, Roth IRAs provide a mechanism to help our youth take advantage of many years of tax-free earnings.
 
Roth IRAs are also somewhat flexible. It is usually a pretty reliable rule that it is best not to withdraw from a retirement account until age 59 1⁄2 or later. But young savers often require large amounts of money for certain things—buying a car, paying for college, putting a down payment on a house—and because the contributions to a Roth IRA have already been taxed, they can be withdrawn at any age without having to pay an additional tax or penalty (which is why they are more flexible than Traditional IRAs). On the other hand, an account must be open for a minimum of five years and the owner must be at least 59 1⁄2 years old to withdraw earnings both tax-free and penalty-free. However, there are exceptions to these rules for disability of the account owner, first-time home purchases and expenses related to higher education.
 
Last year, Maeve committed to putting $2,000 into her Roth IRA, and Jeff and Jill committed to matching her contributions, bringing the total amount to $4,000. Between Maeve’s earnings from The Flying Bridge and her landscape work at Cutter Financial Group, $4,000 did not exceed her earned income. Max committed to contributing a third of his earnings to a Roth (which Seth and I agreed to match), adding another third to a savings account and keeping the final third for “walking around” money. He continued to do that throughout the winter, when he picked up some work shoveling during the snowstorms.
 
Now, as I explained the first time we addressed this topic, Jeff and I realize that Max and Maeve may be more familiar with the benefits of saving and investing than most teenagers, after having to listen to us for so many years. And we understand that, often, trying to convince a teenager to do something that will help them in 50 years is impossible. So, we believe that quantifying the possible benefits helps quite a bit.
 
Let’s assume at age 15, Max and Maeve can each expect an average rate of 6 percent return on their investments over the years. When they are 30, based on their plan to contribute $4,000 a year, their Roth IRAs will likely be worth almost $110,000. When they are 50, it will be $550,000. At 65—get this—nearly $1.5 million. Jeff and I have explained to our kids that over those 50 years of saving, their total contribution of $200,000, with compounding returns, could turn into $1.5 million! Alternatively, if they were to wait until they are 30 to start contributing to a Roth IRA, their $4,000 per year would only turn into about $375,000, based on the same assumptions. The life lesson here is that a little dedication now will pay off big in the future. By starting early, our youth have time on their side.
 
One last note about Roth IRAs is that, unlike the Traditional IRA, which has required minimum distributions (RMDs) beginning at the age of 70 1⁄2, there is no RMD on a Roth IRA. Not only that, but remember: even if you take a distribution, if done correctly, it is all tax-free!
 
Jeff and I feel fortunate to be able teach the importance of financial responsibility to our Cutter Family Finance readers and through the adult education courses we teach in Falmouth and at Cape Cod Community College. It is our hope that we can also spread the word to not only our own children, but other young people in our community. Can you please help us do that?
 
It is no secret that this young generation needs to be vigilant and stay alert, because, as I’m sure we can all agree, they deserve more.